“Everybody loves money. That is why they call it money.” Danny DiVito from “The Heist”. (Good – but not great – movie.)
The only comment I have about the Presidential election, is that whoever wins the White House and the Senate in terms of the parties in charge, I would hope that they can balance the need for the US economy to grow a faster rate, with real deficit reduction.
The need for deficit reduction is substantial. As Simpson-Bowles concluded, “the era of deficit denial is over”. Dr. David Kelly, JP Morgan’s Chief Economist, says that if Congress and the President try to take the deficit down from its current 7% of GDP to somewhere in the 3% range, this will slam the brakes on economic growth. That kind of deficit reducton would be too contractionary for the US economy. It would probably result in the Treasury rally continuing, but a too-drastic attempt to reduce the deficit wouldn’t be good for the US stock market.
Wednesday morning, if I had to pick one data point to watch that might fully reflect or discount Tuesday’s results, it would probably be the 10-year Treasury yield.
The “forward 4-quarter” earnings estimate for the S&P 500 fell slightly last week to $110.58, down from the previous week’s $111.14, and has now fallen 5 weeks in a row, although not by a big percentage. Year-over-year growth for the key metric is 5.3%, still above the late July, early August nadir of 1% year-over-year growth.
With 367 of the S&P 500 reporting q3 ’12 earnings month-to-date, Q3 ’12 S&P 500 earnings have fallen -0.6% year-over-year while revenue growth has fallen -0.4% year-over-year.
Q4 ’12 earnings growth has slowed to an expectation now of +6.7%, versus +9.9% as of October 1st, and +13.9% as of July 1st. The expected year-over-year growth for technology earnings estimates for q4 ’12 is now -0.1%, versus +9.4% on October 1st, and +15.3% on July 1st, so analyst estimates have really reined in expectations for the S&P 500’s largest sector, for what is typically the seasonally-strongest period of the year for tech spending. A lot of this is Apple’s typically-low-balled guidance for the Christmas holiday, since Apple is now such a big part of technology and the S&P 500. (See more comments on AAPL below.)
Financial sector earnings estimate are a pleasant surprise: Financials are the only sector within the S&P 500 to have seen higher growth expectations since July 1, for Q3, ’12, Q4 ’12, and Q1 ’13. Here is a brief table of how Financial sector earnings estimates have tracked the last 3 months: (near column is week of Nov 2, middle column is as of October 1, 3rd column is as of July 1):
Q3 ’12 +7.6%, +5.3%, +4.2%
Q4 ’12 +30.2%, +28.9%, +26.6%
Q1 ’13 +9.6%, +8.4%, +6.4%
No other sector within the S&P 500 shows this steady progression in earnings, which might help explain the good relative strength in financials since this S&P 500 correction started in mid-September.
Finally, according to the attached spreadsheet, this is the 2nd consecutive quarter where analyst estimate increases werent convincingly above the 50% level. This spreadsheet goes back quite a way, with the highlighted blocks showing the key reporting season for each quarter. As the reader can see, the 2nd quarter was actually worse than the current quarter – at least in q3 ’12, we are getting to 50% / 50% revision rates, indicating that in the last few weeks, analysts are becoming a little more aggressive on estimates.
We think Q3 ’12 will be the bottom for S&P 500 earnings although q4 ’12 is looking a little gamey too. I didn’t think Q4 ’12 estimates would be reduced to this level.
Trading / market update
* Apple is now stupid cheap, in our opinion as we wrote on SeekingAlpha this week. Here is the attached article. http://seekingalpha.com/article/973031-why-apple-s-numbers-tell-us-not-to-worry?v=1351952908&source=tracking_notify. If we exclude the $121 billion of balance sheet cash, AAPL is trading at 9(x) cash flow, which is in-line with the S&P 500’s cash-flow valuation currently, but an investor gets 23% revenue growth and an expected 13% earnings growth rate for fiscal 2013, which would be the slowest rate of growth since 2009. (Long AAPL)
* One element that caught our eye on the Apple spreadsheet as we wrote today’s piece is that fiscal 2013 is the only year we’ve seen (since 2007) that analysts expect AAPL to grow revenues faster than earnings, i.e. no operating leverage. Analysts have REALLY screwed down their margin expectations for tech’s premier company today, and after the last earnings report. The last two quarters of fiscal 2012, AAPL grew revenues faster than earnings (in advance of product launches, such as the iPhone 5 and the iPad Mini).
* Another reason for AAPL’s recent weakness could be selling or trimming positions in front of expected higher capital gains tax rates in 2013, with the fiscal cliff. Frankly, I think it is too late to sell now. $550 is the 50 week moving average for AAPL.
* IBM’s earnings and revenue estimates were unchanged to slightly higher despite the stock dropping 10% after the last earnings report. IBM is a good value here as well. IBM is trading about 11(x) cash-flow. (Long IBM)
* Technology and consumer staples are the 2 most oversold sectors of the S&P 500’s 10 sectors, with just 31% of tech stocks and 36% of consumer staples stocks trading above their 50-day moving averages, Telecom too is oversold. Financials haven’t been dented at all, probably due to the positive estimate revisions cited above. Industrials were oversold, but have recovered nicely.
* Ford had a monster Q3 ’12 earnings report on Tuesday, while the market was closed. The stock had a good October, up 13%. We havent updated our spreadsheet yet, but the North American pre-tax auto margin was at an all-time high for q3 ’12. If only Europe could just stabilize. Ford’s early 2011 high print for the stock was $18 per share. Can a resurgent F earn $3 per share in a “normal economy” ? (Long F, went a little longer on Wednesday.)
* Starbuck’s (SBUX) had a great earnings report on Thursday, with the stock up 19% on 3(x) average volume on Friday, in a bad tape. What a franchise. Here is our earnings preview for SBUX as seen on SeekingAlpha: http://seekingalpha.com/article/962831-starbuck-s-earnings-preview-another-classic-growth-stock-as-cpg-will-drive-future-growth. (Long SBUX)
* Jeff Miller has a great blog post out (A Dash of Insight) this weekend on the election and such: http://oldprof.typepad.com/. The only thing we think can put a serious dent in earnings would be the fiscal cliff, and the cuts would have to be draconian given how low earnings expectations are currently.
* This coming week, we get department store reports, like Kohl’s, Macy’s, Nordstrom’s as well as Whole Foods, and even CVS. Our earnings preview for Whole Foods is on SeekingAlpha already, and CVS will be up late tonight or tomorrow. (long WFM, CVS)
However this week is all about the elections: remember, it isnt just the White House, but the potential Senate majority shift that could be critical.
Watch the 10-year Treasury Wednesday – that will be our key tell. A strong rally in the 10-year on Wednesday, and we will probably see slower growth, a harsher fiscal cliff and a weaker stock market. A sharp selloff in the 10-year on Wednesday and / or next week, and we might see faster growth ahead.
Thanks for stopping by and reading our earnings and market thoughts.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA